Volatility? It's Even More Than You Might Think

Many investors appear to have reacted with complete surprise and near disbelief
to the huge drop in the value of their stock funds between Oct. 2007 and March
of this year. As you are surely aware, losses in value from the highs, which
were at a record level, to the lows, were typically around 60% over a wide
range of stock funds. (As of 5-30-09, the losses in the S&P 500 Index have
been trimmed to about 40%). Individuals so affected might have felt that losses
such as this "just weren't supposed to happen."

But when we look back over the history of the stock market's up and downs,
you will see that extreme multi-year volatility has always been part
and parcel of stock investing.

If you protest by saying there have hardly been such extreme drops since the
Great Depression, remember that volatility refers not only to drops in
stock prices but also to large gains. And, whenever the stock market
goes up a great deal, there is no reason why it can't come down a great deal
as well.

A look at the following table shows that extreme downs and ups happen frequently
enough that they are likely to impact most investors every few years.

Starting Dates
for Bear & Bull Markets
and Subsequent Losses/Gains

Start

Bear or Bull

Total Change

Start

Bear or Bull

Total Change

05/29/46

Bear

-29.6%

11/28/80

Bear

-27.1%

5/19/47

Bull

+23.9

8/12/82

Bull

+228.8

6/13/49

Bull

+267.1

08/25/87

Bear

-33.5

08/02/56

Bear

-21.6

12/4/87

Bull

+79.9

10/22/57

Bull

+86.4

07/16/90

Bear

-19.9

12/12/61

Bear

-28.0

10/11/90

Bull

+417.9

6/26/62

Bull

+79.8

07/17/98

Bear

-19.3

02/09/66

Bear

-22.2

3/24/00

Bear

-36.8

10/7/66

Bull

+48.0

9/21/01

Bull

+21.4

11/29/68

Bear

-36.1

1/04/02

Bear

-33.8

5/26/70

Bull

+73.5

10/09/02

Bull

+101.5

01/11/73

Bear

-48.2

10/09/07

Bear

-51.9

10/3/74

Bull

+73.1

11/21/08

Bull

+27.4

9/21/76

Bear

-19.4

1/06/09

Bear

-28.7

3/6/78

Bull

+61.7

3/09/09

Bull

+36.6

Note: Bull market
starting 3/9/09 total change thru 5-30-09

Bull markets rallies can occur within secular (very long) bear markets; likewise,
bear markets can occur in on-going longer-trend bull markets. These reversals
are included in the above table. Without them, some bear/bull markets would
appear as even greater losses/gains, such as during the 2000-2002 time period
when the S&P 500 dropped a total of 49.1% from top to bottom, even though
the table shows the period as two less severe bear markets with a bull sandwiched
in-between.

As you can see, a downward or upward change of 20% or more (or nearly so)
happens relatively frequently. So, since 1946, there have been 30 major changes
of direction, occurring on average every 2.1 years. These changes eventually
lead to some pretty big gains or losses. While the gains have been bigger than
the losses, if we just look at the absolute size of the change, you can see
that the 51.9% loss suffered recently beginning in Oct. 2007 (and -56.8% if
measured through March) is about in line with the average losses or gains during
the 30 periods of change.

The bottom line? Investors in the stock market need to be aware of the extremely
volatile nature of the stock market. While the very long-term trend of the
market has always been positive, getting through any period of time less than
5 to 10 years years has always been fraught with danger. There is frequently
the possibility of a big drop. Not only that, there is no rule of investor
safety saying that if the market gained 100 or more percent as in did between
2002 and 2007, that it can't give up such gains, and even more so in a subsequent
bear market. This is what happened recently and has happened before.

Given such volatility, any investor must accept the fact the such risks are
ever-present. It is to ignore history to assume that one can be invested in
the market and be able to skate free of these dangers. Thus, unless you are
a trader, you always need to be able to stay at least 5 to 10 years in your
stock investments, if necessary, to be reasonably assured of not suffering
from the worst bear markets can dish up.

And, as my free Newsletter has
always stressed, you should always be more willing to invest in the market
when valuations are relatively low vs. when they are relatively high.

When you put money to work in the market makes a big difference. You can't
just assume that any time is a good time; you should be extremely patient,
waiting as long as necessary for periods of market underperformance before
investing more. We also believe that once it appears that the market, or pockets
within it, are too highly valued, you should be willing to take profits, seek
out areas of under-valuation, or even retreat to alternative investments such
as bonds.

Looking at the big picture, we think that stocks in general are closer to
being under-valued than they are over-valued. Or, put otherwise, if you were
willing to invest more (or remain fully invested in stocks) during the years
2005 through late 2007, you shouldn't have nearly as many qualms about doing
so now as you might have had back then.

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